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WHAT WE LEARNED ON THE WAY TO OUR PUBLISHERBy Wayne H. Wagner and Ralph A. RievesDuring a sunny 2007 spring week in New York, we

attended two different investment conferences. Inside thehalls of each conference the outlooks were equally sunny.Surprising to us because earlier that spring both WanenBuffet and the late Peter L. Bemstein had commentedabout the astonishing perceptions of low risk embedded inasset prices. We were surprised that the opinions ofthese two sages weren't addressed from he podiums ateither conference. Moreover, hardly anyone mentionedthese alanning articles in any of the informal sessions.

We found these cursory responses to the wellreasoned concems of Buffet and Bemstein perplexing:"What are most of these people thinking about if they'reignoring the concems of two of the brightest minds in ftebusiness?" The answer was given to us later in the weekby two other experienced and successful observens of thebusiness. Summarized, the answer was: 'Nof a hell of alot ... and ffie consequen@s are goingto be ugly.'

Later in the month, we leamed that this concem wasshared by offier people whose opinions we had leamed toappreciate. They had eamed our appreciation by theirhabit of thinking about their thinking. They viewed assetmanagement as an everchanging series of challengesencountered among all the elements and playens in theglobal capital madtets. They identified the challenges,reflected on them, assessed the attendant risks and thenmade decisions they and their clients could live by.

During the summel we found ourselves engaged indiscussing this 'state of the business" with trustees,academics, and regulatorc. Some of them encouraged usto undertake a book. Soon after, we had recruited someof those whose work we appreciated to contribute to thebook. By that Fall things had definitely tumed "ugly."

While compiling the book we enhanced ourappreciation of how much the future all of us are strivingfor depends on our thinking about the relationshipsamong all playens in the capital markets; as well asreappraising the consequences of astonishing digitalvelocity. Markets are comprised of people and people willact like people. Regardless of how quickly information isretrieved, it still has consequences which can result frcmthe conclusions drawn and the actions taken.

What follows are some of what we leamed or werereminded about as we worked on the book.1. We Need to Be Cool

We build our mindsets, models and our reputations onour experience. But our experience can never cover allthe possible situations that may occur. As Bemsteinwisely wamed, 'Being wrong on occasion is a disagree-able reality.' The situation is particularly disagreeablewhen it challenges our rationality and exposes the deepemotions that arise while sailing in uncharted watem.Thus, there is no such being as a totally rational client,and therc will never be a portfolio manager who cancontinually ouperform the market.

These systemic or macro economic disruptions forceus to reexamine our core assumptions. For example, weleam that statistical distributions are not always 'normal"and our faith in slatistical certainties may be misplaed.We leamed that the covariances we measure maybecome unstable just when we rely on them the most. Wemay need to slow down the tempo to guard against knee-jerk reactions such as finger pointing, panic selling, or(spare us all) another rush to more regulation.

2. We Need to Retain a Sense of HistoryMarkets get out of balance, and we quickly forget that

the record shows they seem to go crazy every few years.Publicly traded companies emerge and disappear. Smartpeople occasionally will be wrong, very wrcng. The storyof the wodd is full of unexpected instances, both fortuitousand calamitous. A heightened sense of perspective mightbe the best attribute we can have.

The past we grew wise in may or may not replay,particularly in the short term. We may need to adjust to a"safe mode" in the face of ovenuhelming uncertainty. Wedare not lose the capacity to spring into action. Perhapsin ways that are entirely new to us, but that are demandedby the changing environment. Adaptabili$ is the key tosurvival in economic as well as biological environmentalchange. We don't know how much we don't know. Butwhat we don't know is always out there, waiting for us.

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3. The Study of Finance ls InterdisciplinaryMuch has been written about the behavioralists'influence. Now no one thinks that investment

management remains just an amalgam of accounting,statistics, and economics. Moreover the contribution ofthe behavioral school has extended beyond how invest-tors make {or don't make) decisions, but into brainscience as well. (How much dopamine is activated by asizable retum on an investment?) The political scientist'shad-nosed acknowledgment of inefficiency juxtaposesthe economist's predilection for the observable, and themethodology of biology is now being applied to the studyof markets as evolving organisms. We see potential forexciting breakthmughs.

4. lt's All About the ClientsWell, duhl You would h surprised (as we were) byhow often the focus is not on the only essential element:the multi-dimensional needs of the client. Note that

Bemstein and Buffet have never thought of themselves asMasters of the Univene. They are respected becausethey maintained their humility and their focus on theclients. Perhaps clients were overcharged by sky-highmanagement fees in too many instances, but this is ftekind of problem that encompasses its own solution, Whatconcemed us most was the discovery of how littletrustees and beneficiaries know about the rudimentaryelements of investing. C,aveat Emptor is not anappropriate axiom in many cases. ln loco parentius isappropriate where levels of sophistication are vasilydifferent. The burden is on the trustee leadership andconsumer activist groups. We need from them anunending commitment to design and promote anenvironment which assures that pertinent decisions aremade consistent with the Prudent Investment Rule. Thereis ample opportunity for consultants to .do the right thing".

5. Technology Has Empowered the Buy Side

Conspiracy theorists may not agree, but we believethat the consequences of being caught Tront running" aresevere enough to dissuade attempts to do so, even withinthe cunent nanosecond time frame. Hence, thecontinued improvement of tnading systems favons theportfolio managers and their clients over market insidens.

This power shift just may be the most significantchange in the history of the capital markets.

The competition among venues has long replacedcompetition among brokerdealers. Economic rents formarket making have come down, activating an ability totum the resultant transaction costs into betterperformance. Only thus can portfolio managers justify thefees they charge to clients.

6. lt's lmportant to Manage the Business TooManaging the enterprise is just as important asmanaging the p,ortfolios. Hiring, training, and retaining

managers, tmden, and support staff who walk the firm'swalk and talk its talk is an inestimable competitiveadvantage. Having everyone on the same page promotesefficiency and client empathy. Rigorous and easilymonitorcd cost controls and compliance systems willassure that less time is spent putting out fires, and moretime is spent meeting client needs and growing thebusiness. A key tenet of budgeting should be to assurethe maintenance, enhan@ment, and refinement of theinformation systems has first call on the operating funds.

7. Keep ThinkingIn a time when capital flows instantly through borders,that which enhanced rctum this moming might not workafter lunch. Amorg the many enduring values held byPeter Bemstein was a commitment to lifelong leaming.We agreed with him that what distinguishes proficientinvestment managerc is that "they think about their

thinking.'

Wayne H. Wagner is the lead principal of OMo NI. Ralph A Rieves is the managing director of Farragut, Jones, & Lawrence.They are the editors of Investment Management: Meeting lhe Noble Challenges of Funding Pensions, Deftcits, and GrowthI (WILEY, August 20fi)).